Fifteenth General Review of Quotas

With the January 2016 effectiveness of the Fourteenth General
Review of Quotas and the entry into force of the Amendment
on the Reform of the Executive Board, the IMF turned its
attention to the completion of the next review by October 2017.

The Executive Board’s work on the Fifteenth Review was
postponed due to the delay in effectiveness of the package of
quota and governance reforms—known as the 2010 reforms—
in the context of the Fourteenth Review.

On February 1, 2016, the Executive Board notified the Board
of Governors that on January 26, 2016, the Board Reform
Amendment entered into force, which would allow the quota
increases under the Fourteenth Review to become effective.
As the Executive Board had not yet formed a view on the
adequacy of quotas in the context of the Fifteenth Review, it
proposed that the Board of Governors continue the Fifteenth
Review. On February 19, 2016, the Board of Governors adopted
a Resolution, expressing regret that the Fifteenth Review
had not been completed and calling on the Executive Board to work expeditiously
on the Fifteenth Review
in line with previous
understandings, with the
aim of completing the
review by the 2017 Annual
Meetings.

Box 4.1: The Quota Formula

The current quota formula was agreed in 2008. It includes four
variables (GDP, openness, variability, and reserves), expressed
in shares of global totals, with the variables assigned weights
totaling to 1.0. The formula also includes a compression factor
that reduces dispersion in calculated quota shares with a greater
impact on large economies than small ones. The formula is:

Y = a blend of GDP converted at market exchange rates
and purchasing power parity (PPP) rates averaged over a
three-year period. The weights of market-based and PPP
GDP are 0.60 and 0.40, respectively;

O = the annual average of the sum of current payments and
current receipts (goods, services, income, and transfers) for
a five-year period;

V = variability of current receipts and net capital flows (measured
as the standard deviation from a centered three-year
trend over a 13-year period);

R = 12-month average over one year of official reserves
(foreign exchange, SDR holdings, reserve position in the
Fund, and monetary gold);

and k = a compression factor of 0.95. The compression
factor is applied to the uncompressed calculated quota
shares which are then rescaled to sum to 100.

A comprehensive review of the quota formula was concluded
in January 2013 and important progress was made in identifying
key elements that could form the basis for a final agreement
on a new quota formula. It was agreed that achieving
broad consensus on a new quota formula will best be done in
the context of the Fifteenth Review rather than on a standalone
basis (see “Report of the Executive Board to the Board
of Governors on the Outcome of the Quota Formula Review”).

On April 16, 2016, the IMF
International Monetary
and Financial Committee (IMFC) strongly welcomed “the
effectiveness of quota increases” of the Fourteenth Review and
of the Amendment on the Reform of the Executive Board. The IMFC called on the Executive Board
to “work expeditiously toward
completion” of the Fifteenth Review,
including a new quota formula,
by the 2017 Annual Meetings. The
IMFC said it looks forward to a
progress report at its
meeting during the 2016
Annual Meetings.

The IMFC communique
said: “Any realignment
under this [Fifteenth]
Review is expected
to result in increases
in the quota shares of
dynamic economies in
line with their relative
positions in the world
economy, and hence likely in the share of emerging market
and developing countries as a whole. We are committed
to protecting the voice and representation of the poorest
members. We reaffirm our commitment to maintain a strong,
quota-based, and adequately resourced IMF.”

Financial Sector Assessment Program Agenda in FY2017

The Fund’s Financial Sector Assessment Program (FSAP),
which assesses the stability of countries’ financial systems, will
turn focus on some of the largest and most connected financial
systems during FY2017. IMF FSAPs are being conducted in
a number of euro area countries for the first time since the
transformation of the regulatory and supervisory environment
by postcrisis reforms, notably the establishment of the
European Banking Union.

In the wake of the global financial crisis, the IMF Executive
Board agreed in 2010 that the world’s top 25 financial systems
would undergo a mandatory financial check-up every five years.
The FSAP underwent its most recent review in FY2015 when
the list was expanded to 29 countries. The countries that will
conclude their financial stability assessments under the FSAP in
FY2017 include Germany and the United Kingdom along with
Ireland, Mexico, Russia, and others. The assessment work on
China and Spain has begun and will be completed in FY2018.

The FSAP assesses three key components of financial stability
in all countries:

The resilience of banks and other major financial
institutions, including through stress tests and analysis of
systemic risk factors;

The quality of financial system oversight—taking into
account the macroprudential framework—including banking,
securities, insurance, and other subsectors where deemed
systemically important; and

The ability of policymakers and financial safety nets to
withstand and respond effectively to deep financial stress.

The overarching goal of FSAP assessments is twofold: to gauge
the stability and soundness of the financial sector and to assess
its potential contribution to growth and development. The
IMF tailors country assessments to analyze issues of particular
interest or concern in each country. In FY2017, the IMF teams
will focus their analysis on systemic risks, interconnectedness,
and macroprudential and crisis-management policies. FSAP
findings also provide valuable input to the IMF’s broader
surveillance of countries’ economies under the Article IV
consultation process.

Fiscal Work in Progress

ANALYZING AND MANAGING FISCAL RISKS: BEST PRACTICES

As underscored by the global financial crisis and the more
recent collapse in commodity prices, comprehensive analysis
and management of fiscal risks can help ensure sound fiscal
public finances and macroeconomic stability. Indeed, over the
past quarter century, governments experienced on average an
adverse fiscal shock of 6 percent of GDP once every 12 years.

The IMF is playing an important role in supporting
improvements in fiscal risk analysis and management among
its members. A paper, “Analyzing and Managing Fiscal Risks,”
released in early FY2017, explains how countries need a more
complete understanding of the potential threats to their fiscal
position. A comprehensive and integrated assessment of the
potential shocks to government finances, in the form of a fiscal
stress test, can help policymakers simulate the effects of shocks
to their central forecasts. Comprehensive, reliable, and timely
fiscal data covering all public entities, stocks, and flows are a
necessary foundation for such analysis.

The paper finds that countries should enhance their capacity
to mitigate and manage fiscal risks by expanding their toolkits
for fiscal risk management and using instruments to transfer,
share, or provision for risks. In doing so, they need to weigh
the possible benefits from reducing their exposure to shocks
against the financial and other costs of the policies that may be
needed.

Countries should make greater use of probabilistic forecasting
methods when setting long-term objectives and mediumterm
targets for fiscal policy. These can be used to map the
uncertainty around medium-term trajectories for public debt.
In combination with fiscal stress tests, these tools can provide
valuable information about the probabilities that a country will
stay within the debt ceilings embedded in their fiscal rules.

The IMF assists the membership in assessing and managing
fiscal risks by providing technical assistance on constructing
public sector balance sheets, developing institutions and
capacity to identify specific fiscal risks and to quantify their
potential impact, conducting fiscal stress tests, and integrating
risks into the design of medium-term fiscal targets.

TAX POLICY, LEVERAGE, AND MACROECONOMIC STABILITY

A Board paper to be issued in FY2017 on “Tax Policy, Leverage,
and Macroeconomic Stability” explores the macroeconomic
stability effects of various tax policy designs. One key issue
is how the current discrimination between debt and equity
in many corporate tax systems affects the leverage choice of
firms. By encouraging high corporate debt ratios, such tax
incentives may increase firms’ distress and ultimately have
implications for macroeconomic stability risks.

The paper examines the effectiveness and efficiency of
tax policy reforms that neutralize this debt bias, such as
alternative types of restrictions to the deductibility of interest,
equivalent deductions for returns on equity, and combinations of the two. Using firm-level data and a newly created database
on thin-capitalization rules, the paper empirically assesses the
impact of recently introduced policies on corporate debt ratios
and examines the impact on broader indicators of corporate
default risk. It also assesses the revenue implications of
different reforms.

The paper also explores the role of corrective taxes to mitigate
financial stability risks: for instance, special bank levies can
stimulate capitalization of banks and thus enhance financial
stability. Moreover, tax policies such as capital gains taxes,
property transaction taxes, and recurrent property taxes can
be used to influence property price developments, thereby
possibly mitigating risks. These policies are assessed against
their broader welfare implications.

Income and Gender Inequality

In recent years, the work of the IMF on macroeconomic issues
increasingly has turned to analysis and policy advice on issues
related to income inequality and gender inequality. This work
has come to be recognized as relevant and important to the
policies developed to strengthen economic growth in the Fund’s member countries—developing, emerging market, and
advanced economies alike.

In its April 2016 communiqué, the IMFC welcomed work
on the issues of “income inequality, gender inequality, [and]
financial inclusion,” provided they are “within the Fund’s
mandate and where they are macrocritical, and by leveraging
the experience of other institutions.”

While the Fund began addressing these areas with
groundbreaking research early in the decade, in FY2015 and
FY2016 it began to also shift toward applying the findings
in pilot countries. The next phase of the work will involve
deepening the Fund’s understanding of the policy implications
of the analysis in a broader range of countries, and integrating
that understanding more fully into policy advice.

INCOME INEQUALITY

Considerable research has been undertaken to analyze the
linkages between inequality and growth and discuss the
impact of fiscal policy on inequality. Most notably papers on
“Inequality and Unsustainable Growth” (2011), “Redistribution,
Inequality, and Growth” (2014), and the book Inequality and
Fiscal Policy (2015), have recently been published. Work has
been extended into the IMF’s flagship publications, notably the October 2015 African Regional Economic Outlook, which
includes a chapter on “Inequality and Economic Outcomes
in Sub-Saharan Africa,” and the May 2016 Asia and Pacific
Regional Economic Outlook, which included a chapter on
“Sharing the Growth Dividend: Analysis of Inequality in
Asia.” Various Working Papers also took up the topic, notably
“Sharing the Growth Dividend: Analysis of Inequality in Asia.”

During FY2016, staff analysis was discussed with the
authorities of nine pilot countries and incorporated into
surveillance reports, notably the annual “health check” on
individual countries called the Article IV consultation report.
Those reports are considered by the IMF Executive Board, and
the Board’s views are transmitted to the country authorities.

Among the topics addressed in the Article IV consultation
reports of the pilot countries relevant to inequality are:
comparative analysis of inequality and poverty outcomes, the
inclusiveness of growth, expenditure composition, subsidy
reform, tax progressivity, and financial inclusion. In some
cases, the Article IV analysis assessed a reform roadmap or
plan already developed or
under consideration by the
authorities.

In the coming year, IMF work
on inequality will seek to deepen the focus on policy trade-offs, reforms, and costs. It will
also tie the inequality analysis to the Fund’s work on structural
reform, particularly in developing countries, where the linkages
between growth-related reforms and inequality are particularly
relevant. This will be a theme of a major research paper during
the year on structural reform, inequality, and growth.

With the amount of work already undertaken across countries
and departments, the process of “knowledge exchange”
becomes more central—disseminating the work itself,
the underlying methodologies and tools, and the country
experiences. Considerable energy will be devoted to work
inside the IMF aimed at sharing knowledge and developing
synergies that will help scale up inequality work and its impact.

Box 4.2: Combating Climate Change

The IMFC, in its April 2016
meeting, expressed support
for the Fund’s ongoing work on climate change. Following
up on the release of a Staff Discussion Note on the fiscal,
macroeconomic, and financial implications of climate change
in January 2016, work in this area shifted toward pilot country
efforts on energy pricing—long established as an area of
IMF expertise.

Energy pricing is already covered in both surveillance and technical
assistance. The pilots, for countries in Africa, the Middle
East, and the Western Hemisphere, focus on issues such
as the distributional impact of movements toward automatic
pricing and assessing taxes to address environmental costs.

Other country work has explored specific climate-related
issues, such as a Selected Issues paper in the Mexico
Article IV report on “A Carbon Tax Proposal for Mexico,” the
introduction of a carbon tax in the context of the U.S. Article
IV consultation, and a study of the macroeconomic and price
effects of El Niño in 33 countries.

In the wake of the December 2015 international agreement in
Paris providing a framework for progress on climate change mitigation,
carbon pricing is expected to become more important in
many countries. The IMF plans to develop tools to assist countries
and anticipates higher priority being assigned to technical
assistance in this area. Further work on policy development to
address climate issues may be required going forward.

GENDER INEQUALITY

Fund work on gender inequality is following the same model of
linking groundbreaking research to country work—integrating
analytical findings and methodology into the daily work of the
institution.

Two important papers that deepened the Fund’s work in the
area were published during FY2016: “Catalyst for Change:
Empowering Women and Tackling Income Inequality,” a Staff
Discussion Note; and ‘Unlocking Female Employment Potential
in Europe: Drivers and Benefits,” which explores direct links
between income and gender inequality. Another working
paper, “Trends in Gender Equality and Women’s Advancement,”
examined trends in selected indicators of gender inequality and
women’s advancement, and gender inequality indices.

As with the work on income inequality, the pilot country
work expanded during the year. An initial group of country
teams analyzed gender issues and discussed findings with
their counterparts in member countries. The findings
then were included in the Article IV reports and discussed
by the Executive Board. Most of the pilot cases involved
a combination of analysis and policy recommendations,
particularly in the form of Selected Issues papers issued, along
with Article IV staff reports. The country cases analyze the
drivers of female labor force participation and point to policy
options within the scope of IMF expertise, including public
infrastructure spending, the expansion of childcare services,
and the role of labor market institutions.

For example, as part of the 2016 India Article IV report, a
Selected Issues paper on the “Macroeconomic Impacts of
Gender Inequality and Informality in India” was prepared.
The paper analyzed the macroeconomic impact of gendertargeted
policies on labor market outcomes for females and on
aggregate economic activity.

In addition to the initial group of country pilots, several other
country teams are working on gender inequality in the context
of their Article IV consultations across several regions, work
that will progress during FY2017.

Other work that will be carried forward in the coming fiscal
year includes follow-ups on several pilot cases and crosscountry
studies that will include the impact of macroeconomic
policies on gender gaps, and gender inequality and growth.
An important focus will be on gender budgeting, with a series
of papers that will overview gender budgeting ideas and survey
efforts worldwide, to provide a basis for countries to draw
ideas for their own initiatives. This work will also produce a
data set on gender budgeting efforts that can assist countries
in developing ways to incorporate gender considerations in
government programs and policies.

Finally, a major book on women, work, and economic growth
addressing the intertwined challenges of growth, job creation
and gender equality” will be released before the 2016 Annual
Meetings.

Corruption: Costs and Mitigating Strategies

While the direct economic costs of corruption are well known,
the indirect costs may be even more substantial and debilitating,
leading to low growth and greater income inequality. Corruption
also has a broader corrosive impact on society. It undermines trust
in government and erodes the ethical standards of private citizens.

A recent estimate put the annual cost of bribery at about
$1.5 trillion to $2 trillion—roughly 2 percent of global GDP.
In an environment in which growth and employment
prospects in many countries remain subdued and high-profile
corruption cases have fueled outrage, addressing corruption
globally—in both developed and developing countries—is
increasingly important. There is a growing consensus that
corruption can seriously undermine a country’s ability to
deliver inclusive growth.

An IMF Staff Discussion Note titled “Corruption: Costs and
Mitigating Strategies,” released in early FY2017, focuses on
corruption that arises from the abuse of public office for
private gain, whether through transactions such as bribery
or through networks between business and government that
effectively privatize public policy. The IMF’s experience in
helping member countries address corruption suggests that
priority needs to be given to transparency, the rule of law, and
effective institutions.

The IMF promotes compliance with international standards
for transparency and accountability in such areas as data
dissemination, fiscal policy, and monetary and financial policy.
It has published 11 fiscal transparency evaluations on countries
that include Bolivia, Finland, Ireland, and the Philippines.
Working closely with the Financial Action Task Force (FATF) and its regional bodies,
the IMF also assesses
compliance with
international standards
to help countries
prevent money
laundering. It provides
policy advice, expertise,
and training.
The Fund also has
helped countries
avoid or get off the
FATF’s “blacklist” of
countries perceived to
be noncooperative in the global fight against money laundering
and terrorist financing. Recent cases in Latin America include
Costa Rica, Paraguay, Peru, and Uruguay, where the presidents
endorsed anti-money-laundering strategies developed with the
IMF. In Ghana, Myanmar, Nepal, and Sudan, the IMF’s support
helped the countries in moving off the gray list.

To embed financial integrity principles and practices into
government ministries and central banks across the globe,
the Fund supports institutions in such areas as financial
intelligence, legislative drafting, national strategies, risk
assessments, and the supervision and regulation of bank and
nonbank entities. The IMF provides advice to strengthen fiscal
frameworks and budget preparation with the goal of enhancing
the role of the budget as the central instrument for allocating
public resources. In FY2015, it sent some 100 technicalassistance
missions to help member countries with public
financial management, in addition to supporting countries
through nine Regional Technical Assistance Centers in Africa,
Asia, Latin America, and the Middle East.

Global Challenges

Eight years after the onset
of the global financial crisis,
the world economy continues
to face uncertain prospects.
Growth in most advanced
economies remains lackluster,
and many emerging market
and developing countries face
slower growth. Not only is
growth low, in many cases it
has been shared unequally,
which can create additional
challenges, including
undermining support for
reforms and openness to trade
and migration.

While financial markets
and some commodities fell
sharply early in the year, by
mid-February they started
recovering, but the June
23, 2016 vote in the United
Kingdom to exit the European
Union increased uncertainty.
The turn of events caused the
IMF in its July 2016 World
Economic Outlook update to
revised down modestly its
forecast for growth in 2016 and
2017 from the April WEO.

The Fund, in a note to the July
2016 meeting of G-20 Finance
Ministers and Central Bank
Governors in China, identified
several key policy areas in
which action urgently needed
to be taken to contain risk and
reinvigorate growth in the
short and longer terms:

Reducing uncertainty around “Brexit” and its repercussions.

A smooth and predictable transition to a new relationship
between the UK and EU that as much as possible preserves
gains from trade is essential. While uncertainty about the
outcome of negotiations remains, policymakers should stand
ready to act decisively should financial market turbulence
threaten the global outlook.

Implementing effective macroeconomic support.

Where demand is still falling short, a broad-based approach
is required that exploits policy synergies by combining
structural and balance sheet reforms with continued
monetary support and growth-friendly fiscal policies—
including using available fiscal space, anchored by strong
policy frameworks. Stronger domestic demand support,
especially in creditor countries with policy space, would also
help reduce external imbalances.

Addressing debt overhangs.

In many advanced economies, balance sheet repair remains
critical to lift investment, contain vulnerabilities, and improve
monetary transmission. Addressing corporate debt and other
financial risks is also important in a number of emerging
economies and a key ingredient of China’s transition to a new
growth model. In some cases, this might require the use of
public sector resources.

Lifting long-term growth and making it more inclusive.

The G-20 can lead by encouraging strong implementation
of the G-20 growth strategies, and prioritizing structural
reforms that have a high short-term growth impact. A staff
paper prepared for the G-20 meeting outlined the priorities for
structural reforms in the G-20 countries.

Strengthening multilateral action.

Reinvigorating trade integration remains crucial to boost
global growth, as is making sure that the gains from trade are
shared widely. And it remains important to strengthen global
safety nets, including by monitoring geopolitical spillovers
that could threaten the global recovery.